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Valve’s Newell Explains Exactly Where Microsoft Went Wrong

It comes down to a fundamental strategic decision.

Gabe Newell knows a thing or two about the PC business. As of one of Microsoft's (NASDAQ:MSFT) earliest employees and the managing director of Valve (a stalwart of the PC gaming industry), Newell's opinions about the future of the PC deserve consideration.

Unfortunately for his former employer, Newell doesn't think too highly of Microsoft's current strategy. In fact, he suggests that the PC's problems are largely the by-product of the Redmond tech giant's own flawed decision making.

Linux is the futureThe very survival of Newell's company, Valve, depends on the health of Microsoft's Windows business. Steam, the company's digital marketplace, exists mostly on computers running some version of Microsoft's Windows.

Perhaps not for much longer. At LinuxCon on Monday, Newell declared that Linux -- the open-source operating system -- was the "future of gaming." Valve has been working hard at porting Steam over to PCs running Linux, and has been steadily adding Linux compatibility to a growing, although still small, base of Steam games.

Microsoft embraces a closed systemNewell is trying to move on from Windows, because as he sees it, Microsoft has made a terrible mistake.

The rise of mobile computing platforms has led to the creation of closed systems, or walled gardens. Unless you jailbreak your iPhone, you can install only apps from the iTunes store. In Apple's (NASDAQ:AAPL) opinion, this allows it to offer a better user experience. It can monitor the quality of apps and keep malware in check.

But as Newell notes, it has some interesting consequences from an innovation and competitive standpoint:

Several years ago we got very concerned about directions that the PC industry was going...there were these new platforms that were starting to emerge...they had this nice characteristic that you could control access to those platforms. If you didn't like competing with Google(NASDAQ:GOOGL), you just didn't let them ship on your device...you could have a lot of control over things like pricing...that was a very seductive opportunity, which I think led to some poor decision making by some of the key actors in the PC space.

Although Newell didn't mention Microsoft by name, he is almost assuredly referring to the Windows maker. Windows 8, the most radical redesign of the Windows operating system since 1995, embraced a far more closed system than its competitors. Full Windows 8 is still capable of running traditional PC applications, but the new side of Windows -- the touchscreen-optimized part built around the Metro interface -- is tightly controlled. Here, Microsoft runs its own app store, and has taken steps to block its competitors' products. Last year, a Mozilla chief lashed out at Microsoft for the restrictions it placed on rival browsers like Firefox and Chrome.

Microsoft is becoming more like AppleBased on Microsoft's recent reorganization and purchase of Nokia's handset business, that decision to embrace a closed system is starting to play out.

Microsoft's reorganization aims to orient the company around "devices and services." Until Windows 8, Microsoft was simply a software company that sold operating systems and applications that ran on other companies' hardware; nowadays, Microsoft is actively involved in the hardware-creation process, with its lineup of Surface tablets. With Nokia, Microsoft will be producing its own Windows Phones. Could there come a day when Microsoft is also making its own laptops and desktops? Such an idea doesn't seem far-fetched.

With control over hardware and control over software, Microsoft is becoming more like Apple. Of course, Apple has emphasized closed systems from its earliest days. Steve Jobs was perhaps the biggest proponent of the closed-system ideology, once declaring that "open systems don't always win."

Except it seems they do, at least in the long run. When Apple shares were skyrocketing and the King of Cupertino was taking over the world, the notion that a closed system can win out over an open one seemed plausible. Today, that's a much more difficult argument to make.

Apple's share of the global smartphone market has dwindled in recent years, and now sits at just 14% of the market. At the same time, Google's Android has emerged to dominate the planet, and presently accounts for about 79% of the smartphones sold worldwide.

Google owes its success with Android to its embrace of an open model. Like traditional Windows, Android is open in the sense that all developers are free to code for it. Although Google has its own app store, it doesn't make many attempts at policing it, and Android apps can be easily loaded onto devices outside of Google's app store, or by using third-party app stores, and nearly all hardware manufacturers can use it. Google takes this idea to the next level, giving Android away for free.

Research firm Gartner expects Android to become the world's dominant operating system by 2017. Certainly, it's hard to compete against free.

Microsoft's bad betFundamentally, Newell believes Microsoft went astray when it decided to copy Apple's closed-system model. Closed systems, though they can offer superior user experiences, inevitably lose out to open systems in the long run. Google's Android may offer a lesser user experience when compared to Apple's iPhone, but Google has been able to crush Apple in market share largely because it gives its operating system away for free, and allows hardware manufacturers to compete against one another.

Although Microsoft benefited from an open model in the 1990s, the company appears focused on converting to a closed system, with its reorganization around devices and services and its purchase of Nokia serving as proof.

If Newell is correct in his assessment, investors shouldn't expect much from Microsoft's Windows division.